Alison Frankel

When U.S. Senior District Judge Jed Rakoff rejected a $285 million settlement between Citigroup and the Securities and Exchange Commission last fall, he offered a stern rebuke to SEC lawyers who’d suggested his role was not to protect the public interest. “A court, while giving substantial deference to the views of an administrative body vested with authority over a particular area, must still exercise a modicum of independent judgment in determining whether the requested deployment of its injunctive powers will serve, or disserve, the public interest,” Rakoff wrote in his oft-quoted ruling. “Anything less would not only violate the constitutional doctrine of separation of powers but would undermine the independence that is the indispensible attribute of the federal judiciary.”

In the months since, at least three other federal judges have cited Rakoff in questioning whether settlements proposed by federal agencies serve the public interest, two in SEC cases and one in a Federal Trade Commission case. The SEC adopted a minor, mostly cosmetic revision in the policy that so provoked Rakoff — in which defendants are permitted to settle without admitting liability — but otherwise insisted that such compromises are the very foundation of federal enforcement efforts.

On Thursday, the agency’s position received a very powerful endorsement from the 2nd Circuit Court of Appeals. A three-judge panel ruled that the SEC’s case should be stayed pending a joint appeal of Rakoff’s ruling by the agency and Citigroup, overturning a Rakoff order that the case proceed. The extraordinary 17-page appellate ruling concludes that Citi and the SEC are likely to succeed in their argument that Rakoff was wrong to reject the settlement.

“The S.E.C. asserts that its settlement is in the public interest and that its access to a stay so as to protect the settlement is also in the public interest,” said the per curiam ruling by Judges John Walker, Pierre Leval, and Rosemary Pooler. “We are bound in such matters to give deference to an executive agency’s assessment of the public interest …. We have no reason to doubt the SEC’s representation that the settlement it reached is in the public interest. We see no bases for any contention that the SEC’s decision to enter into the settlement was ‘arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.’”

Rakoff “misinterpreted” precedent on his discretion to evaluate the public interest, the appellate judges found, and exceeded his judicial authority: “The responsibilities for assessing the wisdom of such policy choices and resolving the struggle between competing views of the public interest are not judicial ones,” the opinion said.

District court judges are not supposed to be rubber stamps for federal agencies, the appellate panel said, but nor are they “to dictate policy to executive administrative agencies.” Rakoff’s analysis of the SEC’s policy of entering settlements without insisting on admissions of liability, the court said, didn’t offer sufficient deference to the SEC.

“It is commonplace for settlements to include no binding admission of liability,” the opinion said. “A settlement is by definition a compromise. We know of no precedent that supports the proposition that a settlement will not be found to be fair, adequate, reasonable, or in the public interest unless liability has been conceded or proved and is embodied in the judgment. We doubt whether it lies within a court’s proper discretion to reject a settlement on the basis that liability has not been conclusively determined.”

Interestingly, the ruling is per curiam, or unsigned, perhaps because none of the appellate judges wanted to be singled out as harshly critical of Rakoff. Adding to the intrigue, Rakoff is scheduled to sit by designation on a 2nd Circuit panel Friday morning to consider (among other cases) an appeal of the dismissal of an auction rate securities class action. The defendant in the ARS case? Citigroup!

In a discussion that should be a huge relief to the SEC and defendants, the appeals court said Rakoff’s insistence on an admission of liability would undermine the agency’s ability to set its own enforcement agenda. Not only was Rakoff wrong in proclaiming his discretion to weigh the public interest, according to the 2nd Circuit, but he was wrong on whether the public is served by the SEC’s policy. “We question the district court’s apparent view that the public interest is disserved by an agency settlement that does not require the defendant’s admission of liability,” the panel said. “Requiring such an admission would in most cases undermine any chance for compromise.”

Thursday’s decision only addresses the preliminary question of whether the case should be stayed in the lower court while the full appeal takes place, and the panel takes care to say that the judges who ultimately hear that appeal are “free to resolve all issues without preclusive effect from this ruling.” The opinion also said that the 2nd Circuit will appoint counsel to brief and argue Rakoff’s side in the full-blown appeal, partially answering a question my colleague Carlyn Kolker posed.

Citi counsel Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison said in an email that Citi is “pleased with the 2nd Circuit’s ruling.” An SEC spokesman did not respond to an email request for comment.

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Over the last six months, U.S. Senior District Judge Jed Rakoff has made Irving Picard of Baker & Hostetler look more like Don Quixote than a white knight riding to the rescue of investors who lost billions in Bernard Madoff’s Ponzi scheme.

Rakoff has already squelched the Madoff trustee’s fraud claims against the banks that allegedly aided and abetted Madoff’s scheme, as well as cutting off Picard clawback claims that date back more than two years. On Tuesday, in Rakoff’s biggest-dollar ruling in the Madoff case, the judge said Picard does not have standing to pursue a $60 billion racketeering suit against UniCredit and two other foreign banks that allegedly participated in a scheme to funnel $9.1 billion to Madoff in exchange for kickbacks to a woman named Sonja Kohn. (Picard had claimed $20 billion in damages, which can be tripled under the Racketeer Influenced and Corrupt Organizations Act.)

Interestingly, Rakoff did not use the same analysis to dismiss the RICO claims as he did in tossing fraud claims against UniCredit and the other banks. In a quick dismissal of the fraud counts, the judge reiterated his July 2011 holding that Picard can’t stand in the shoes of Madoff investors to assert fraud against the financial institutions that allegedly abetted Madoff’s Ponzi scheme. He could have simply said the same is true in the trustee’s racketeering case (which is what I assumed he would do when I wrote about the fraud dismissal in July). Instead, Rakoff seemed to accept, for the purposes of considering the banks’ motion to dismiss, Picard’s argument that Sonja Kohn’s alleged racketeering scheme was, at least to some extent, distinct from Madoff’s scam.

That was, however, Picard’s only success. Rakoff, who is the co-editor of a leading guide to RICO litigation, found that Picard’s RICO suit against the foreign banks failed under at least three defense theories. First, Rakoff said, Picard couldn’t show a link between the banks’ alleged participation in Kohn’s kickback scheme and any injury to Madoff investors. The trustee tried to rely on a 1992 ruling by the U.S. Supreme Court in Holmes v. SIPC, which acknowledged the difficulty of proving indirect injuries under RICO. But Rakoff said Picard was misreading Holmes. According to the judge, the Supreme Court’s ruling requires RICO plaintiffs to establish a direct connection to the defendant’s conduct.

The judge also rejected Picard’s extremely nuanced argument for why his RICO claims against UniCredit and the other banks are not barred by the Private Securities Litigation Reform Act. According to Rakoff, the 2nd Circuit Court of Appeals has held, in a case called MLSMK v. JPMorgan Chase, that under the PSLRA, securities claims cannot serve as predicate acts in a civil RICO suit. (A related 3rd Circuit ruling specifically said that the bar applies to RICO claims related to a Ponzi scheme.) Picard tried a tricky argument, asserting that because Madoff investors can’t bring a securities case against UniCredit and the other banks under Morrison v. National Australia Bank, the PSLRA bar shouldn’t apply to their RICO suit. Rakoff rejected Picard’s reasoning, noting that RICO has its own limits under Morrison, according to the 2nd Circuit’s holding last month in Cedeno v. Castillo.

“[Picard's argument] is too clever by half and would in many cases allow artful pleading to eviscerate either the territorial reach of the Securities Exchange Act or the purpose of the RICO Amendment to the PSLRA,” the judge wrote.

Finally, and most fundamentally, Rakoff said that Picard hadn’t alleged sufficient facts to proceed to discovery under the heightened pleading standards the U.S. Supreme Court established in Ashcroft v. Iqbal. In a fairly cursory consideration of the trustee’s complaint, Rakoff derided Picard’s “paltry and otherwise unexceptional” allegations, writing that the trustee casts his assertions in a “sinister” light only by “invoking the specter” of a RICO scheme.

UniCredit counsel Susan Saltzstein of Skadden, Arps, Slate, Meagher & Flom said the bank is pleased with Rakoff’s ruling. A spokesperson for Picard sent me an email statement: “The SIPA Trustee and his counsel remain confident in his RICO and common law claims against [UniCredit and related defendants]. The SIPA Trustee will appeal to the United States Court of Appeals for the Second Circuit.”

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The Solicitor General’s office of the Department of Justice is home to some of the smartest lawyers in the country. These are the people who represent the views of the United States in the most important public policy cases at the U.S. Supreme Court. They go on to head appellate practices at prestigious law firms — or to their own seats in the federal judiciary. Lawyers in the SG’s office are accustomed to deference.

Jed Rakoff, however, isn’t much for deference.

In a Feb. 7 ruling on a claim of attorney-client privilege in a Freedom of Information Act dispute, the Manhattan federal court senior judge conceded that when the Solicitor General’s office makes a representation to a court, “trustworthiness is presumed.” But Rakoff said that when he dug into the SG’s justification for an assertion in a 2009 case at the Supreme Court, he couldn’t find anything aside from some emails exchanged amongst lawyers in the office. “It seems the government’s lawyers were engaged in a bit of a shuffle,” the judge said.

He cited a Peter Finley Dunne aphorism — “Trust everybody but cut the cards” — but might just as well have quoted Ronald Reagan’s famous “Trust, but verify” (itself an adaptation of a Russian proverb favored by Vladimir Lenin). Because Rakoff couldn’t verify the SG’s assertion in the Supreme Court brief, except in emails over which the Justice Department was claiming privilege, he said privilege doesn’t shield parts of the emails.

The dispute stems from a brief filed in a case called Nken v. Mukasey, which posed the question of whether aliens are entitled to a stay of deportation orders until all their appeals are exhausted. In a January 2009 brief, the Solicitor General’s office assured the Supreme Court that the United States has a “policy and practice” of helping deported aliens who are subsequently cleared return to this country and “the status they had at the time of removal.” The Justices relied (in part) on that assurance in holding that aliens aren’t entitled to a stay because they aren’t irreparably harmed by deportation. (The case name changed to Nken v. Holder because President Obama had taken office when the opinion was issued in April 2009.)

The National Immigration Project, the American Civil Liberties Union and some other public interest groups had doubts about the asserted “policy and practice,” for which the Solicitor General’s brief didn’t offer a specific citation. So they filed a FOIA request with the Justice Department, the State Department and the Department of Homeland Security. The Solicitor General’s office produced only a four-page email chain, which was almost completely redacted. The Justice Department asserted three theories of privilege over the emails: work product, attorney-client, and deliberative-process.

The plaintiffs sued for access to the email, arguing that only the Solicitor General communications could clarify the supposed policy or reveal that the Justice Department mistakenly cited a policy that doesn’t exist.

Rakoff agreed, after reviewing the emails and the materials other arms of the government produced in response to the FOIA request. None of those materials, he found, indicated that the United States has a policy and practice of helping wrongfully deported aliens return to this country. Nor did a memorandum of understanding the Justice Department cited to Rakoff. “The OSG made a new factual representation on appeal and cited nothing in the record to support it,” he wrote. “The government even now has come forward with nothing of consequence to support its representation beyond the facts set forth in the emails.” (And Rakoff didn’t seem to consider the email chain very good justification: “As reviewed by the court in camera, evidences an attempt to cobble together a factual basis for making the representations the OSG made to the Court in Nken,” Rakoff wrote.)

Since the SG communications amounted to a statement of policy, Rakoff said, it can’t be shielded from the public. He ordered the disclosure of all portions of the emails that “contain factual descriptions of the putative policy.”

Gregory Garre, the Latham & Watkins partner who was Solicitor General when the Nken brief was filed and appears as counsel of record on the document, declined comment. I also left a phone message with Deputy Solicitor General Edwin Kneedler, who argued the Nken case at the Supreme Court, and with the Justice Department’s Office of Public Affairs. None of them got back to me.

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On Wednesday, the Financial Industry Regulatory Authority disclosed a settlement with Citigroup that U.S. Senior Judge Jed Rakoff might find interesting. Citi agreed to pay a $725,000 fine to resolve allegations that it committed thousands of disclosure lapses in research reports issued between January 2007 and March 2010. (A big thanks to my Thomson Reuters colleague Stuart Gittleman of Accelus, who told me about Citi’s FINRA deal.) Among other disclosure problems, Citi failed to note its role as a manager or co-manager of a related public offering in 8 percent of the 80,000 reports it issued annually; it neglected to report investment banking revenue in 330 research reports; and it didn’t disclose its beneficial ownership in about 1,800 companies its analysts covered.

The FINRA consent letter, signed by Citi counsel Robert Romano of Morgan, Lewis & Bockius, sure makes it sound as though Citi was aware of its disclosure failures. The bank itself identified most of the lapses, which violated strict FINRA disclosure guidelines imposed on Wall Street firms after a 2003 investigation of conflicts of interest in analyst reports. (Citi agreed to pay a $400 million fine after that investigation.) The bank has already conducted two internal reviews of its disclosure systems, one in conjunction with a previous $350,000 fine for lapses committed between 2004 and 2006. In 2010, after continuing problems with internal systems and data from outside affiliates, Citi hired an independent consultant to recommend improvements in its technical disclosure processes. In Wednesday’s consent, the bank agreed (again) to accept a FINRA censure, which is now part of its permanent disciplinary record.

But you won’t find any outright admission of wrongdoing by Citi in Wednesday’s signed consent. To the contrary, the document is sprinkled with the phrase that has become known as Rakoff’s Scourge: “without admitting or denying.” Citi didn’t admit or deny the latest batch of disclosure failures, just as it didn’t admit or deny regulatory allegations in 2003 or alleged disclosure failures in 2006. The latest FINRA consent repeats the boilerplate from Citi’s two previous disclosure agreements with the industry regulator.

There’s no mystery why Citi favors such settlement language. Even though the FINRA consent bars the bank from implying in any way that FINRA’s allegations are unfounded, it also expressly states that “nothing in this provision affects [Citi's] right to take legal or factual positions in litigation or other proceedings in which FINRA is not a party.” That means that if Citi is accused of disclosure lapses by shareholders — or even by the SEC — it’s not hamstrung by the agreement with FINRA, however much it appears to concede in the consent letter.

Nor is FINRA’s reflexive acceptance of “without admitting or denying” boilerplate terribly surprising. As I’ve reported, that’s the standard language of enforcement agreements between corporate defendants and federal regulators, whether the Justice Department, the Commodity Futures Trading Commission, or the Federal Trade Commission.

Rakoff’s rejection of Citi’s proposed $285 million settlement with the Securities and Exchange Commission has certainly put a spotlight on such settlement language. The SEC, you’ll recall, recently conceded the silliness of its boilerplate in settlements involving defendants who have already admitted to or been convicted of related criminal charges. So it’s fair to ask why FINRA had no fear of including “without admitting or denying” language in the Citi consent.

The answer is that FINRA is an industry regulatory body, not a government agency whose settlements must be reviewed and approved by a federal judge. FINRA’s enforcement department must satisfy only itself of the fairness of a consent deal. In other words, no judge can call out FINRA or the bank for reaching a settlement that obscures the facts and violates the public interest.

FINRA said in a statement that Citi “failed to make required conflict of interest disclosures which prevented investors from being aware of potential biases in its research recommendations,” even though the statement went on to note that Citi “neither admitted nor denied the charges.” (Go figure.) The agency had similar language in an August 2010 press release announcing a similar settlement with Morgan Stanley, which agreed to pay a $800,000 fine for disclosure failures.

Citi counsel Romano of Morgan Lewis referred my call to a Citi spokesperson, who sent an email statement: “We are pleased to have settled this matter with FINRA. We take our disclosure systems very seriously and began adopting enhancements to our procedures prior to the inquiry.”

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Late Friday the Securities and Exchange Commission confirmed in a statement what the New York Times first reported Friday morning: it has changed its policy on the boilerplate “neither admit nor deny” language in most SEC settlement agreements. But don’t get too excited. The change will affect only cases in which the defendant has admitted guilt or been convicted in a related criminal action. In settlements with those criminal defendants, the SEC will delete “inconsistent” concessions and instead “recite the fact and nature of the criminal conviction or criminal [admission] in the settlement documents.”

In other words, defendants whose guilt has already been established under the higher standard of criminal law can no longer evade responsibility for civil charges. Which leads, of course, to the question of why it took the SEC 40 years to change such a ridiculous policy.

In the weeks since U.S. Senior District Judge Jed Rakoff of Manhattan federal court rejected the agency’s proposed $285 million settlement with Citigroup for misleading investors about a synthetic CDO, the SEC has argued long and loud that the boilerplate Rakoff scorned is intrinsic to its ability to reach settlements with defendants worried about liability in follow-on civil suits by private plaintiffs lawyers. I get that. And as I’ve reported, just about every other federal agency with enforcement power has a similar practice of permitting defendants to settle without conceding they’ve done anything wrong. I have my doubts that deleting pro forma “neither admit nor deny” language from settlement agreements would result in a dramatic change in the value of follow-on private settlements, but perhaps I, like most federal judges, have become inured to boilerplate.

Still, let’s think for a minute about just how absurd it is to include “neither admit nor deny” language in settlements with admitted or convicted criminals. My Reuters colleague Grant McCool points out, for instance, that when BernieMadoff settled with the SEC in June 2009, he wasn’t required to admit wrongdoing, even though he’d already pled guilty to running the biggest Ponzi scheme in history. Crazy, right? And I haven’t noticed anyone citing Madoff’s SEC settlement to suggest that maybe he isn’t civilly liable for defrauding investors.

Seriously: Does any corporate defendant facing civil exposure from a criminal admission or conviction really believe the SEC boilerplate confers any protection from private suits? That’s like saying you’re not naked if you’re wearing Saran Wrap for underwear.

The irony is that the SEC gains as little as defendants lose in the policy change. The agency went out of its way to assert that the revision wasn’t prompted by Rakoff’s crusade. Its statement said the policy change came after “a review by senior enforcement staff that began this spring and separate discussions with the Commissioners over the last several months,” and that it is “separate and unrelated to recent rulings in the Citigroup case.” (And, in fact, the revised policy wouldn’t have changed the boilerplate in the Citi agreement, since that case doesn’t involve a parallel criminal admission or conviction.) I suppose the SEC could argue that at least it can no longer be ridiculed for settlements like the one it reached with Madoff.

But any scrutiny of its “neither admit nor deny” boilerplate can’t be good for the SEC as it challenges Rakoff’s ruling in the Citi case. If no one takes the language seriously, why include it?

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Former Goldman Sachs director Rajat Gupta and his lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, declared what might seem to be a very strange kind of victory last week when the Securities and Exchange Commission agreed to drop its administrative proceeding against Gupta. The two-page stipulation between Gupta and the SEC makes it clear that the SEC isn’t giving up on its claims that Gupta engaged in insider trading when he allegedly passed confidential information about Goldman Sachs and Procter & Gamble to Galleon Group hedge fund chief Raj Rajaratnam. All Gupta won was a pledge that the agency will sue him in federal court. And that is indeed a huge victory.

The SEC chose an anomalous vehicle for its March 1 suit accusing Gupta of helping Rajaratnam engage in insider trading. Instead of bringing a case against Gupta in Manhattan federal court — as the SEC did when it sued 28 other Galleon insider trading defendants — the agency filed what’s known as a public administrative proceeding. Those proceedings take place before an administrative law judge under SEC rules, not the federal rules of civil procedure. There’s no jury, and the first appeal of any adverse ruling goes to the SEC commissioners, not to an appeals court.

As Gupta counsel Naftalis laid out in his March 18 federal court complaint against the SEC, the differences between an SEC administrative proceeding and a federal court case added up to a big pile of prejudice against Gupta. Gupta wouldn’t be able to take depositions or conduct full discovery to counter the SEC’s assertions. The SEC, meanwhile, would be able to introduce hearsay evidence that it might not be able to get into evidence in federal court, according to the Gupta complaint. “The only plausible inference is that the Commission is proceeding how and where it is against Mr. Gupta for the bad faith purpose of shoring up a meritless case by disarming its adversary,” the complaint asserted.

The SEC’s attempt to sue Gupta in an administrative proceeding was all the more reprehensible, Gupta claimed, because the SEC has no regulatory power over him. He’s not an officer of a public company or a broker-dealer, or in any other position that falls under the purview of the SEC. Instead, the agency relied on provisions of the Dodd-Frank Wall Street Reform Act to bring the Gupta case as an administrative proceeding — even though all of Gupta’s alleged misconduct took place before Dodd-Frank was passed.

Gupta and Naftalis argued that the retroactive application of Dodd-Frank to hamstring Gupta’s defense amounted to an unconstitutional violation of his due process rights, since he alone, of all the Galleon defendants, had been sued in an administrative proceeding. In the federal court suit, which landed before Judge Jed Rakoff, Gupta and Naftalis asked for a declaration that the SEC can’t apply the Dodd-Frank civil penalty provisions retroactively and an injunction barring the SEC from bringing an administrative proceeding against Gupta.

The SEC’s response, styled as a motion to dismiss Gupta’s federal court complaint, essentially said that the agency has the right to sue Gupta where it wanted to, and if he didn’t like the SEC’s choice of forum, he could just wait until the end of the administrative proceeding to appeal.

Judge Rakoff sided with Gupta. “A funny thing happened on the way to this forum,” he wrote in a July 11 opinion (with no apology to Stephen Sondheim). “The Securities and Exchange Commission — having previously filed all of its Galleon-related insider trading actions in this federal district — decided it preferred its home turf.” The judge found he had jurisdiction over the case by virtue of the U.S. Supreme Court’s 2010 ruling in Free Enterprise Fund v. Public Company Accounting Oversight Board, and concluded that Gupta could litigate his constitutional due process claim in federal court, en route to the injunction he had asked for.

Instead of appealing Rakoff’s ruling, the SEC agreed to last week’s stipulation. The agreement, said an agency spokesman, doesn’t let Gupta off the hook. “The staff is committed to the case against Mr. Gupta and will proceed as appropriate,” spokesman John Nester told me.

But as Gupta counsel Naftalis said in a statement to Reuters at the time, the stipulation gives Gupta everything he wanted in his suit against the SEC-a chance to defend himself in federal court. “Mr. Gupta denies all allegations of wrongdoing and stands ready to mount a defense against each and every one of the Commission’s charges,” Naftalis wrote.

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In the end, it wasn’t even a close call.

Using words like “conjecture,” “bootstrapping,” and “a stretch,” Manhattan federal court judge Jed Rakoff on Thursday decimated trustee Irving Picard‘s multibillion-dollar campaign against the banks that allegedly helped Bernard Madoff engineer his fraud, in a 26-page opinion that left no room for doubt. Rakoff so thoroughly rejected each and every one of Picard’s arguments for why he had the right to bring common law fraud claims against HSBC and UniCredit that the judge didn’t even cite much legal precedent through the first half of the ruling. He simply applied what he calls “ordinary use of the English language” to conclude that no reading of the relevant laws or cases grants Picard standing to sue the banks for unjust enrichment and aiding and abetting fraud and breach of fiduciary duty. This ruling derived its power — and it is a very powerful opinion — from its simplicity.

Rakoff’s ruling immediately affected Picard’s $6.6 billion case against HSBC and a parallel $2.2 billion case against UniCredit. But it’s going to have huge repercussions beyond those suits. Judge Rakoff is also presiding over Picard’s $60 billion racketeering case against UniCredit and related defendants, and it’s a certainty that UniCredit’s lawyers at Skadden, Arps, Slate, Meagher & Flom will ask the judge to apply his ruling on Picard’s standing and bounce that suit as well.

Meanwhile, Judge Colleen McMahon, who is Judge Rakoff’s neighbor on the 14th floor of the Manhattan federal courthouse, is poised to rule on Picard’s standing in his common-law suits against UBS and JPMorgan Chase. McMahon is certainly an independent-minded judge so it would be a mistake to assume she’ll simply follow Rakoff’s lead. But Rakoff knew full well how intensely his ruling on Picard’s standing would be scrutinized, and nevertheless showed no equivocation in his opinion. It’s hard to imagine Judge McMahon reaching a contrary conclusion.

If McMahon — and, ultimately, the appellate courts — agree with Rakoff, Picard’s audacious attempt to hold the banks responsible for failing to end Madoff’s Ponzi scheme is doomed. As I reported a few weeks back, Picard’s standing to bring common-law claims against the banks is a threshold issue. To prosecute a suit, you have to be able to show that you were injured. Picard, as the bankruptcy trustee in the Madoff Chapter 11, stands in the shoes of the debtor, Bernard L. Madoff Investment Securities. But his common-law claims against the banks weren’t brought on behalf of Madoff’s now-defunct investment company — which, as Rakoff explained in Thursday’s ruling, is barred from suing alleged co-conspirators like the banks by a doctrine called in pari delicto. Instead, Picard’s lawyers at Baker & Hostetler said they were bringing claims against the banks on behalf of Madoff’s customers, who lost billions when Madoff’s scheme was exposed.

HSBC’s lawyers at Cleary Gottlieb Steen & Hamilton and UniCredit’s Skadden counsel countered that as bankruptcy trustee, Picard has no right to stand in the shoes of Madoff’s customers.

In Thursday’s ruling, Rakoff analyzed each of Baker & Hostetler’s proposed justifications. In their most basic argument, Picard’s lawyers said the trustee has the power to sue on behalf of Madoff investors under the Securities Investor Protection Act. SIPA, they said, gives the trustee the right to investigate claims against third parties, so, by extension, the trustee has the power to prosecute those claims. Rakoff said Picard was misreading the law. “Neither the language nor the structure of SIPA supports this conjecture,” he wrote. “The trustee argues that [his] investigative authority would be ‘academic’ if he could not use the information discovered in such investigations to commence law suits against third parties on behalf of defrauded customers. To say this argument is a stretch would be to give it more credence than it deserves. If Congress had intended to confer upon the trustee authority to seek contribution for payments of customer claims, it would have said so in SIPA.”

Baker & Hostetler also proposed that Picard has implied standing under the Exchange Act of 1934, which has a provision segregating customers’ assets from those of a broker-dealer to protect investors when an investment house goes under. Rakoff said he was “mystified” by the argument that the Exchange Act somehow confers powers that SIPA doesn’t. In any event, he said, the Exchange Act provision “cannot be read to grant the trustee additional standing, because the rule, which requires broker-dealers to segregate all cash in their possession for the benefit of customers, says nothing about a SIPA trustee’s standing to bring common law claims against third parties.”

Finally, Rakoff rejected Picard’s arguments that he has standing to sue the banks under the common law theory of bailment, which says someone who holds property on behalf of someone else (like a dry cleaner who has temporary possession of your clothes) can bring claims on the property owner’s behalf; and as the enforcer of the Securities Investor Protection Corporation’s derivative right to bring claims on behalf of investors. Baker & Hostetler’s support for those theories rested on an old opinion by a divided panel of the U.S. Court of Appeals for the Second Circuit in a case called Redington v. Touche-Ross. The Redington ruling was later overturned on different grounds by the U.S. Supreme Court, and at the June 23 oral argument before Judge Rakoff on Picard’s standing, lawyers for the trustee and the banks split on whether Redington’s conclusion on a bankruptcy trustee’s right to sue is still good law, given that the decision was reversed for other reasons.

Rakoff said in Thursday’s opinion that Redington is no longer good precedent — but went on to conclude that even if it were, the ruling wouldn’t confer standing on Picard in the Madoff cases because the facts aren’t parallel. “Redington does not anywhere hold that a SIPA trustee has standing to pursue common law claims against third parties as bailee of customer property,” Rakoff wrote.

As Jonathan Stempel reported for Reuters, Picard’s spokeswoman said the trustee’s lawyers are analyzing the ruling and can’t yet comment on it. HSBC’s Cleary lawyers didn’t return my calls. UniCredit counsel Marco Schnabl of Skadden said, “We’re pleased with the decision. We’re analyzing it to see where we’ll go from here.”

(Reporting by Alison Frankel)